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Emerging markets stocks have lagged those in the U.S. for years. Now with the dollar weakening and developing economies set to enjoy post-Covid 19 growth, some financial advisers are turning bullish on this volatile sector.
When people think about emerging markets, China often comes to mind, but funds that invest in emerging markets often cast a larger net to include countries such as Argentina, Brazil, Chile, Colombia, Mexico, Peru, and India, among others.
The MSCI Emerging Markets Index, a widely-used benchmark, captures large and mid-cap stocks across 27 emerging markets countries. This index, which had only four positive years of annual performance since 2013, gained 18.4% in 2019 and 18.3% in 2020, after the year got off to a rocky start, largely due to the pandemic.
“We think that it’s a signal that investors think economic growth will be pretty good from here,” says Jason Blackwell, chief investment strategist in the Atlanta office of The Colony Group, a registered investment advisor.
Though there’s been some run-up in emerging markets, Blackwell predicts there is still plenty of room to grow, in part because countries haven’t completely recovered from the pandemic-induced economic shock. Once people get more comfortable with the idea of recovery, spending is poised to increase, he says. Another expected boon for emerging markets is that many central banks have committed to keeping rates low for the next few years. This means that companies should have more leeway to invest in capital expenditures and infrastructure, he says.
Emerging markets are also attractive given research that shows their middle-class populations growing significantly, says Daniel Milan, a financial advisor and managing partner with Cornerstone Financial Services in Southfield, Mich. “That combined with the corporate side are the leading catalysts for the growth opportunities within the emerging market investment landscape,” he says.
To be sure, emerging markets are more speculative and carry more risk than domestic stocks, so they aren’t necessarily for ultra-conservative, faint-hearted investors. Advisors have different views about how much investors should plunk down on these holdings, but generally recommendations range from around 5% to roughly 15%, depending on factors such as an investor’s risk tolerance and other holdings. There are also active and passive options for investing in these markets.
“The longer timeline that you have, the larger [your] appetite for risk, emerging markets can be a really good fit,” says Brian Jass, an advisor in the Vadnais Heights, Minn. office of Great Waters Financial. His firm tends to take a more conservative approach, recommending aggressive investors put about 8% in emerging markets and more conservative investors around 5%, using index funds and exchange-traded funds to keep costs down. (Emerging markets funds tend to have higher expense ratios than domestic or developed-country funds.) Two funds at the top of his list are the DFA Emerging Markets Core Equity Portfolio, which purchases a broad and diverse group of securities associated with emerging markets, and the DFA Emerging Markets Portfolio, which focuses on larger companies within emerging markets.
“We believe that the emerging market asset class is a great investment and it should be held in a broadly diversified portfolio,” Jass says.
In February 2020, Cornerstone Financial Services began recommending clients once again invest in emerging markets, after a hiatus that was based in part on their relative underperformance compared with the S&P 500. In January, the firm increased its emerging markets allocation and may do it again, depending on factors such as the political landscape and how the dollar does over time, he says.
For clients who are in all-stock portfolios, the firm recommends about 12% be allocated to emerging markets. For clients who have a 60/40 split between stocks and bonds, his firm recommends about 8% of the portfolio be earmarked for emerging markets.
While there are many options to choose from, Milan generally recommends the allocation be split between two ETFs Schwab Emerging Markets Equity ETF and First Trust International Equity Opportunities ETF. He likes these funds because they have a strong focus on companies from China, India, Brazil, Russia, Indonesia, Mexico and Turkey, which have a growing representation among Fortune 500 companies.
As they are making investment decisions, Blackwell, who recommends investors allocate 12% to 15% of their portfolios to emerging markets, cautions them not to overlook Latin America as a source of growth. Many advisors focus on Asian-only opportunities. But if you believe that synchronized global growth is about to take off, Latin America is a pretty interesting place to be because countries there have natural-resource heavy economies. “Managers who invest in Asian-only strategies may be leaving money on the table,” he says.